Category Archives: Data and Transparency

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SEC Chief Accountant Wesley Bricker made recommendations to improve the quality of financial reporting for regulatory agencies and firms. He also reviewed developments in non-Generally Accepted Accounting Principles (“non-GAAP”) measures and other areas.

In remarks before the Baruch College Financial Reporting Conference, Mr. Bricker encouraged standard-setting bodies to maintain distinct financial reporting frameworks for general and specific purpose reporting. He explained that general purpose financial reporting should continue to provide crucial business and financial information to shareholders while specific purpose financial reports should remain limited to a “special purpose framework” in order to address more specific needs.

Mr. Bricker identified the means by which firms can improve the quality of interim reviews and annual audits. He stated that firms should implement an “effective firm-wide (enterprise) risk management system” to enhance audit firm governance. He encouraged “independent, diverse thinking” on audit committees in order to improve corporate governance. He emphasized the importance of improving the “tone and culture” of the company in enabling auditors to accomplish their work.

Mr. Bricker mentioned that the SEC is issuing a request for public comment to address compliance challenges related to auditor independence rules. Mr. Bricker promised that amendments to the accounting standards will significantly improve the quality of financial reporting for investors. The amendments include: (i) requiring calendar year-end public companies to report revenue from contracts with customers; (ii) standardized company reporting requirements to help investors compare financial statements across companies; (iii) improving reporting and disclosures of non-GAAP and GAAP to help investors identify how management monitors performance and analysis; and (iv) enhancing the quality of disclosures as to market risk.

Acting Director Tom Pahl of the Federal Trade Commission (“FTC”) Bureau of Consumer Protection confirmed that the FTC is investigating the data privacy practices of Facebook Inc. (“Facebook”) following reports that Cambridge Analytica, a data collection and analytics firm, may have misappropriated the personal information of over 50 million users. Facebook previously settled charges with the FTC in 2011 for deceiving consumers regarding the privacy of their account information. The conditions of that settlement required Facebook to obtain approval from consumers before changing the way it shares their data, and to periodically review its privacy practices. The 2011 charges alleged that Facebook’s practices violated Section 5(a) of the Federal Trade Commission Act, which prohibits unfair or deceptive acts or practices in or affecting commerce.

In addition, a group of 37 Attorneys General issued a letter to Facebook CEO Mark Zuckerberg requesting information on Facebook’s policies and procedures for protecting users’ personal information, as well as the social networking platform’s plans for improving privacy controls and disclosures going forward. Watchdog group Common Cause filed complaints with the Department of Justice and the Federal Election Commission accusing Cambridge Analytica of violating federal election laws.

Earlier this month, Facebook stated that a University of Cambridge professor created an application that used Facebook’s platform to gain access to consumers’ information. At the time, Facebook argued that the situation was not a data breach because consumers knowingly gave away their consent when they signed up for the app. Since then, however, Facebook acknowledged that the professor violated Facebook’s Platform Policies by failing to disclose that the data collected was passed onto data collections and analytics firms, Strategic Communication Laboratories and its affiliate corporation, Cambridge Analytica.

SEC Chair Jay Clayton laid out near-term narrowly focused regulatory goals and committed the agency over the long term to greater transparency. The set of priorities will be published as part of the federal government’s Unified Agenda.

In remarks at the Practical Law Institute’s 49th Annual Institute on Securities Regulation, Chair Clayton discussed the SEC approach to developing the agency’s five-year strategic plan while articulating short-term narrowly focused efforts. He identified the following immediate efforts:

Initial Coin Offerings (“ICOs”): ICOs are vulnerable to price manipulation and other fraudulent actions. The SEC will continue to take steps to warn investors about the enhanced risks presented by ICOs, and to protect market participants from some of these risks. The SEC plans to offer clarification as to (i) how tokens are listed on exchanges (and the standards for listing), (ii) how tokens are valued, and (iii) what protections exist for investors and market integrity.

Fee Disclosures: Hidden or inappropriate fees and expenses can harm investors. The SEC will pursue enforcement for fee disclosure-related cases, and look to clarify fee disclosure requirements in order to reduce opportunities for misconduct.

Penny Stocks: Reliable information is often unavailable for penny stock issuers. The SEC will seek to expose some of the “opaque aspects” of the penny stock market.

Transaction Processing: Transfer agents are “well-positioned” to prevent the distribution of unregistered securities. The SEC will monitor transaction processing, particularly with regard to restricted securities.

Investor Education: The SEC is creating a searchable database that will contain information on individuals who have been barred or suspended due to federal securities law violations.

In terms of long-term initiatives, Chair Clayton identified shareholder engagement and the proxy process as an area of focus. He emphasized the importance of proxy rules in providing an avenue for shareholder engagement, and said the SEC will conduct a close examination of whether the current rules are effectively meeting both shareholder and company needs. Chair Clayton explained further that voting power often sits with investment advisers rather than shareholders, thereby limiting shareholder participation rates in the proxy process. He stated that the proxy process may demand a review and corresponding updates to ensure that long-term retail investors are fairly represented in corporate governance. Regarding shareholder proposals, Chair Clayton said the SEC intends to find common ground between the viewpoints held by all stakeholders. This will include an examination of ownership level thresholds for the submission of shareholder proposals and the resubmission process.

Chair Clayton highlighted the importance of transparency in the securities markets. He noted that enforcement plays an important role in ensuring transparency, and stressed that transparency can play a role in deterring, mitigating or eliminating wrongdoing before an enforcement action becomes necessary.

Lofchie Comment: From a financial policy standpoint, the SEC’s renewed focus on its traditional economic missions (good disclosure, investor protection) is an important change in priorities. When combined with a rulemaking agenda that is limited to achievable and announced goals, businesses are better able to prepare.

The New York Department of Financial Services (“DFS”) cybersecurity regulation requires banks, insurance companies and other institutions regulated by the DFS (“covered entities”) to implement a cybersecurity program to protect consumer data (seeprevious coverage). A covered entity is required to have (i) a written cybersecurity policy or policies approved by the entity’s board of directors or a senior officer, (ii) a “Chief Information Security Officer” in place to protect data and systems, and (iii) other relevant “controls and plans” intended to fortify the safety of the financial services industry.

Firms also will be required to submit a Certification of Compliance annually that concerns the firm’s cybersecurity compliance program. The first such Certificate must be submitted by February 15, 2018. The DFS now requires covered entities to submit notices of certain cybersecurity events to the DFS Superintendent within 72 hours of any occurrence. Covered entities will be able to report cybersecurity events through the DFS online cybersecurity portal. Institutions also will be able to use the portal to file notices of exemption.

DFS Superintendent Maria Vullo commented on the program:

“With cyber-attacks on the rise and comprehensive federal cybersecurity policy lacking for the financial services industry, New York is leading the nation with strong cybersecurity regulation requiring, among other protective measures, set minimum standards of a cybersecurity program based on the risk assessment of the entity, personnel, training and controls in place in order to protect data and information systems.”

Lofchie Comment: As if the life of a compliance officer trying to manage technology risk was not worrisome enough, the NY DFS has now added a state-wide regulatory burden to their job. On the positive side, there is a three-day weekend coming.

A group of central bank representatives and private sector market participants known as the Foreign Exchange Working Group (“FXWG”) released a new version of the “FX Global Code,” a set of conduct standards and principles for foreign exchange (“forex”) market participants. The FXWG was formulated in 2015 in order to “promote a robust, fair, liquid, open, and appropriately transparent market.”

The new version of the FX Global Code expands the topics covered by Phase One of the Code (ethics, information sharing, certain aspects of trade execution, and trade confirmation and settlement) published on May 26, 2016 (see Cadwalader Clients & Friends Memorandum, June 1, 2016). The new version includes: aspects of execution on e-trading and platforms, prime brokerage, governance, and risk management and compliance. Other important topics covered in the new version of the FX Global Code include “pre-hedging” and last-look practices.

As a whole, the FX Global Code covers six broad areas:

ethics;

governance;

execution;

information sharing and confidentiality;

risk management and compliance; and

transaction confirmation and settlement.

Lofchie Comment: The appropriate standards of conduct in the forex market have long been ambiguous, given (1) the absence (until Dodd-Frank) of much of a statutory/regulatory framework, (2) the fact that it is largely a principal market, (3) the limited involvement of lawyers and compliance personnel who might have served as “gatekeepers,” and (4) limited trade reporting information that might have served as a check on misconduct. That period of ambiguity is ending. While the FX Global Code may not have the force of law, regulators and private litigants are likely to point to it as establishing the required standard of conduct.

Many of the principles established in the FX Global Code are basic; e.g., one should strive to do the right thing, firms should manage risk appropriately, and trade disputes should be promptly resolved. Other standards, particularly those related to executing and information walls, will need to be carefully considered as to how they are implemented. Firms should review (or establish) compliance procedures for their FX desks and should compare those procedures to those governing other similar but perhaps more regulated markets.

The CFTC amended its rules to modify the methods by which records must be kept. Under Rule 1.31, firms will no longer be required to (i) retain electronic records in their original format, (ii) keep records in a “non-rewritable, non-erasable format,” or (iii) employ a third-party technical consultant for certain filing requirements. The adopted amendments, including corresponding technical changes regarding recordkeeping, will become effective 90 days after publication in the Federal Register (see also,previous coverage).

Lofchie Comment: Will the CFTC rule changes cause the SEC to revisit its own rules? It would seem to be the right thing to do.

Balance sheet data on two episodes of U.S. central banking are now available in spreadsheet form for the first time. Adil Javat has written a paper that digitizes data on the First Bank of the United States. The bank, established in 1791, was federally chartered and partly owned by the federal government. It was the only bank to have a nationwide branch network because states did not allow banks they chartered to branch across state lines, or in many cases even within them. The bank’s unusual attributes made in in effect a quasi central bank. The Democratic Party objected to it for that reason, and denied the bank an extension when its federal charter expired in 1811. The following year the United States became embroiled in the War of 1812 and missed the services that the Bank of the United States had provided. The U.S. Congress chartered a second Bank of the United States that began operations in 1817. It in turn was denied an extension of its charter by the Democratic Party in 1836. A fire at the U.S. Department of the Treasury in 1833 destroyed many records of the First Bank of the United States, so what remains is fragmentary, and is the fruit of searches of various archives by the 20th century historian James Wettereau. Perhaps more records are still out there, gathering dust somewhere?

Justin Chen and Andrew Gibson have written a paper that digitizes the weekly balance sheet of the Federal Reserve System (now called the H.4.1 release) from the Fed’s opening in 1914 to 1941. Their data will be of interest to anyone interested in the Fed’s behavior during the tumultuous period that included World War I, the sharp but short postwar depression of 1920-21, and the Great Depression. Previously — and surprisingly, given how much has been written about the early years of the Fed — digitized data were only available at monthly frequency. Weekly data should offer finer insights into the Fed’s behavior during episodes in which events were moving fast.

Javat, Chen, and Gibson are all students of CFS Senior Counselor Steve Hanke, and wrote their papers in a research course Hanke teaches for undergraduates at Johns Hopkins University. I read and commented on drafts of the papers.

(For the spreadsheets, see this page.There is a link underneath each paper to its accompanying workbook.)

Before an audience of foreign regulators at the SEC’s 27th Annual International Institute for Securities Market Growth and Development, SEC Acting Chair Michael Piwowar addressed best practices for the regulation of capital formation. He emphasized the importance of disclosure for lowering the cost of capital and for protecting investors, and asserted that a guiding principle for regulators must be to determine whether the government is facilitating or interfering with the progress of capital markets.

Acting Chair Piwowar focused on the value of the disclosure regime. He said that prudential regulation in capital markets is a “misplaced idea,” and added that “while banks are in the business of minimizing risk, the capital markets are in the business of allocating risk.” He argued that disclosure is the most effective tool for allocating capital to the most efficient industries, and suggested that a disclosure regime for banks (which he called “market-based prudential regulation”) could also benefit investors.

In addition, he stressed that a regulatory agency should not “substitute its judgment for that of the market.”

Acting Chair Piwowar also touched on the subjects of enforcement, international cooperation, and emerging issues in FinTech.

Lofchie Comment: During his interim tenure, Acting Chair Piwowar is making significant efforts to return the SEC to its historical mission of enabling investors to make investment decisions on the basis of good corporate disclosure regarding facts of economic significance. These are necessary corrections to the course of an agency that had been used since the adoption of Dodd-Frank as an instrumentality of political partisanship without regard to the economic costs or the benefits of its rulemakings.

Financial Services Committee Chair Jeb Hensarling circulated to Members of the Committee on Financial Services a “Views and Estimates” document for markup. Once adopted by the full committee, the document will be transmitted to the Budget Committee “to be set forth in the concurrent resolution on the budget for fiscal year 2018.”

The document is required by section 301(d) of the Congressional Budget Act which requires “each standing committee to submit to the Committee on the Budget, not later than six weeks after the President submits his budget or upon the request of the Budget Committee: (i) its views and estimates with respect to all matters to be set forth in the concurrent resolution on the budget for the ensuing fiscal year that are within its jurisdiction or function; and (ii) an estimate of the total amounts of new budget authority and budget outlays to be provided or authorized in all bills and resolutions within its jurisdiction that it intends to be effective during that fiscal year.”

The document includes the following recommendations:

“replace the failed aspects of the Dodd-Frank Act with free-market alternatives”;

“place the non-monetary policy activities of the independent agencies within the Committee’s jurisdiction on the appropriations process”;

“replac[e] the Orderly Liquidation Authority with established bankruptcy procedures, wherein shareholder and creditor claims are resolved pursuant to the rule of law rather than the arbitrary discretion of regulator”;

“enhance accountability and lead to greater transparency” at the Consumer Financial Protection Bureau (“CFPB”) by reforming the CFPB’s “operations and unconstitutional structure, including by subjecting the CFPB to Congressional appropriations process, and by reforming the CFPB’s statutory mandate to ensure that it takes into account, and seeks to promote, robust market competition”;

“modernize the SEC’s operations and structure to eliminate inefficiencies”; and

“promote greater accountability at the Federal Reserve by advancing legislation to fund the non-monetary activities of the Federal Reserve’s Board of 33 Governors and 12 regional banks through the Congressional appropriations process.”

Lofchie Comment: If there is an overriding theme in the initiatives contained in the Visions and Estimates document, it is that Congress chooses to assert its authority over the so-called “regulatory state,” or the unofficial fourth branch of the government. Most significantly, Congress is exercising that authority by asserting its funding power over the various regulatory agencies – particularly, the CFPB. Undoubtedly, many of these measures will be seen as reasons for Democrats and Republicans to fight, but that should not be the case with the exercise of the funding powers. The issue raised by these measures is not whether elected Democrats or Republicans are in the right concerning any particular policy decision, but whether regulatory agencies should be able to operate free of the political control of whichever party is in power.

The Visions and Estimates document provides an example of this in a section that examines the funding of the CFPB. Assuming that current CFPB Director Richard Cordray serves out his term, Mr. Cordray will remain in power until some point in 2018; he will keep his position for a substantial part of President Trump’s four-year term. President Trump then will be able to appoint a new CFPB director who could undo much of the previous director’s work and will serve well into the term of the next elected President, who easily could be a Democrat. In short, we could have a situation in which the unelected head of the CFPB is not financially accountable to Congress and acts in opposition to whoever happens to be President at a given time, whether Republican or Democrat. This is no way to structure a regulatory agency. Both Democrats and Republicans ought to prefer the CFPB to be funded by Congress and held accountable by elected political officials.

The CFTC requested comment on a proposal to modernize certain recordkeeping obligations. The proposal would remove a requirement that electronic records be kept in their original format, and would allow recordkeepers to reduce costs associated with paper records through the utilization of “advances in information technology.” The request for comments was published in the Federal Register.

Comments on the proposed amendments must be submitted by March 20, 2017.

Lofchie Comment: The rule proposal would provide welcome updates to the requirements for the storage of electronic records under CFTC Rule 1.31. Significantly, the proposal would eliminate many of the prescriptive requirements of the current rule, including the need for firms to use outdated “write once, read many” (or “WORM”) storage media. Instead, the proposed new rule would adopt a technology-neutral requirement that electronic records be maintained in ways that preserved their “authenticity and reliability.” In addition, the proposal would eliminate the need for firms that store records electronically to (i) appoint a “technical consultant” that agrees to provide the records to the CFTC, and (ii) file a notice with the CFTC regarding compliance with Rule 1.31. However, the proposal also would require firms to implement written policies to assure compliance with the new requirements, including policies for training personnel, and for regular compliance monitoring.

The CFTC’s recent move to a more principles-based approach presents an interesting question: will the SEC follow the CFTC’s lead and modernize SEC Rule 17a-4 along similar lines?